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Accounting Level 3

Model Answers Series 3 2007 (Code 3001)

3001/3/07/MA 1

Accounting Level 3 Series 3 2007

How to use this booklet

Model Answers have been developed by Education Development International plc (EDI) to offer additional information and guidance to Centres, teachers and candidates as they prepare for LCCI International Qualifications. The contents of this booklet are divided into 3 elements: (1) Questions – reproduced from the printed examination paper (2) Model Answers – summary of the main points that the Chief Examiner expected to

see in the answers to each question in the examination paper, plus a fully worked example or sample answer (where applicable)

(3) Helpful Hints – where appropriate, additional guidance relating to individual

questions or to examination technique Teachers and candidates should find this booklet an invaluable teaching tool and an aid to success. EDI provides Model Answers to help candidates gain a general understanding of the standard required. The general standard of model answers is one that would achieve a Distinction grade. EDI accepts that candidates may offer other answers that could be equally valid.

© Education Development International plc 2007 All rights reserved; no part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without prior written permission of the Publisher. The book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover, other than that in which it is published, without the prior consent of the Publisher.

3001/3/07/MA 2

SECTION A (Answer Questions 1 and 2 in Section A − Compulsory) QUESTION 1 Paddington, a sole trader, has the following list of balances at 31 December 2006: £ Capital 192,500 Drawings 28,000 Fixed assets (NBV at 1 January 2006) 140,000 Bank (in hand) 18,560 Cash 2,000 Sales 247,000 Purchases 120,000 Stock (at 1 January 2006) 5,000 Debtors 42,000 Provision for doubtful debts (at 1 January 2006) 4,400 Creditors 10,800 Wages 52,010 Rent 32,000 Sundry expenses 15,130 Despite the trial balance agreeing, the following errors were subsequently discovered: (1) Paddington had paid himself a salary of £1,000 per month and included this in wages (2) Contras of £3,000 between debtors and creditors had been recorded by increasing both debtors and creditors by that amount (3) Closing stock had been valued at £16,000, but included an item costing £750 which Paddington believes could only be sold for £300. Selling costs of £50 would be incurred. (4) No entries had been made in respect of a bad debt recovered of £600: a cheque for this amount was discovered in a drawer. In addition, bad debts of £1,000 needed to be written off and the provision for doubtful debts adjusted to 10% of the revised debtors figure (5) Fixed assets with a net book value of £5,000 have been sold for £3,000. This had been recorded by debiting bank and crediting sales with £3,000. It is Paddington’s policy to calculate depreciation each year by taking 15% of the net book value of assets held at the end of the year (6) No provision had been made for the accountant’s fee of £1,000. REQUIRED (a) Prepare the Trading and Profit and Loss Account of Paddington for the year ended 31 December 2006 and his Balance Sheet at that date. (b) Give three reasons why, despite a Trial Balance balancing, there can still be errors in the underlying book-keeping.

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MODEL ANSWER TO QUESTION 1 (a) Paddington

Trading and Profit and Loss Account for the Year Ended 31 December 2006 £ £ Sales (247,000 – 3,000) 244,000 Less: Cost of goods sold: Opening stock 5,000 Purchases 120,000 125,000 Closing stock (16,000 – (750 – (300 – 50)) 15,500 109,500 Gross profit 134,500 Add: Bad debts recovered 600 Reduction in doubtful debts provision* 900* 136,000 Less: Expenses Wages (52,010 – (1,000 x 12)) 40,010 Bad debts 1,000 Loss on disposal (5,000 – 3,000) 2,000 Accountant’s fee 1,000 Rent 32,000 Sundry expenses 15,130 Depreciation (.15 (140,000 – 5,000)) 20,250 111,390 Net profit 24,610 * Debtors per TB 42,000 Less contra (3,000 x 2) 6,000 36,000 Less Bad debt 1,000 35,000 (10 x 35,000) – 4,400 = 900

3001/3/07/MA 4

MODEL ANSWER TO QUESTION 1 CONTINUED

Paddington Balance Sheet at 31 December 2006

£ £ £ Fixed Assets (140,000 – 5,000 – 20,250) 114,750 Current Assets Stock 15,500 Debtors (35,000 – 3,500) 31,500 Bank (18,560 + 600) 19,160 Cash 2,000 68,160 Current Liabilities Creditors (10,800 – (3,000 x 2)) 4,800 Accrued fee 1,000 5,800 Net Current Assets 62,360 177,110 Capital Account £ Opening Balance 192,500 Add Profit 24,610 217,110 Less Drawings (28,000 + (1,000 x 12)) 40,000 177,110 (b) (i) Transaction completely omitted (ii) The entry for a transaction has been reversed (iii) An entry has been made in the wrong account but on the correct side (iv) The wrong amount has been recorded for the transaction

3001/3/07/MA 5

SECTION A CONTINUED QUESTION 2 Upminster plc depreciates freehold property at 2% per year on cost, calculations being done on a monthly basis. On 1 January 2006 the books showed freehold property costing £200,000, with a net book value of £80,000. On 1 July 2006 the freehold property was revalued by a qualified independent valuer at £260,000. The directors of Upminster plc have decided to incorporate this value in its books. Upminster plc depreciates motor vehicles at 25% per year on cost. A full year’s depreciation is charged in the year of purchase but none in the year of sale. On 1 January 2006 the books showed vehicles costing £80,000, with a net book value of £52,000. On 1 July 2006 Upminster plc acquired an entire fleet of new vehicles costing £210,000. The supplier accepted the old vehicles in part exchange, at a value of £46,000, and the balance was paid by cheque. REQUIRED (a) Prepare the necessary ledger accounts of Upminster plc (excluding Bank and Profit and Loss) to record the above transactions for the year ended 31 December 2006. (b) Show extracts from Upminster plc’s Cash Flow Statement (and Reconciliation of Net

Operating Profit to Net Cash flow from Operating Activities) for the year ended 31 December 2006, resulting from the above transactions.

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MODEL ANSWER TO QUESTION 2 (a)

Freehold Property at Cost/Valuation Account £ £ Opening balance 200,000 Accumulated depreciation 122,000Revaluation reserve (R) 182,000 Closing balance 260,000 382,000 382,000

Accumulated Depreciation on Freehold Property Account £ £ Freehold property at cost 122,000 Opening balance (200,000 – 80,000) 120,000 Profit and loss (.02 x .5 x 200,000) 2,000 Profit and loss 6,667Closing balance 6,667 128,667 128,667*(260,000 ÷ 19.5 years) x 6 months 12 months

Revaluation Reserve Account £ £ Freehold property at cost 182,000Closing balance 182,000 182,000 182,000

Motor Vehicles at Cost Account £ £ Opening balance 80,000 Disposal 80,000Disposal 46,000 Bank (210,000 – 46,000) 164,000 Closing balance 210,000 290,000 290,000

Accumulated Depreciation on Motor Vehicles Account £ £ Disposal 28,000 Opening balance (80,000 – 52,000) 28,000Closing balance 52,500 Profit and loss (.25 x 210,000) 52,500 80,500 80,500

Motor Vehicle Disposal Account £ £ Motor vehicles at cost 80,000 Motor vehicles at cost 46,000 Acc. Depn. on motor vehicles 28,000 Profit and loss - loss 6,000 80,000 80,000

*

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MODEL ANSWER TO QUESTION 2 CONTINUED (b) Extracts from Upminster plc’s Cash Flow Statement for Year Ended 31 December 2006

£ Capital Expenditure and Financial Investment Sale of fixed assets 46,000 Purchase of fixed assets (210,000)

£ Reconciliation of Net Operating Profit to Net Cash Flow from Operating Activities Add: Depreciation (2000 + 6,667 + 52,500) 61,167 Loss on sale of fixed assets 6,000

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SECTION B (Answer any THREE questions from Section B) QUESTION 3 Circle Ltd keeps a Purchase Ledger Control Account, which is part of its double entry book-keeping system. The underlying individual creditors accounts are for memorandum purposes only. The following information is available in relation to creditors for December 2006: £ Opening balances: Purchase Ledger Control Account 14,516 Bayswater Account 2,174 Victoria Account 1,762 Westminster Account 2,142 Embankment Account 3,426 Temple Account 3,716 Blackfriars Account 1,296 Purchases: Bayswater Account 486 Victoria Account 1,201 Temple Account 4,163 Monument Account 1,437 Aldgate Account 912 Purchase returns: Temple Account 307 Aldgate Account 621 Bank (payments): Victoria Account 2,100 Westminster Account 711 Embankment Account 1,428 Temple Account 1,511 Blackfriars Account 1,296 Aldgate Account 200 Discounts received: Victoria Account 120 Westminster Account 100 REQUIRED (a) Write up the Purchase Ledger Control Account of Circle Ltd for December 2006, showing clearly

the opening and closing balances. (b) Write up the individual Purchase Ledger Accounts of Circle Ltd for December 2006, showing

clearly the opening and closing balances on each account. (c) Reconcile the total of the list of Purchase Ledger balances at 31 December 2006 with the balance

on the Purchase Ledger Control Account at that date. (d) Give three reasons why the Purchase Ledger Control Account balance might not agree with the

total of the individual Purchase Ledger balances.

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MODEL ANSWER TO QUESTION 3 (a)

Purchase Ledger Control Account £ £ Purchase returns 928 Opening balance 14,516 Bank 7,246 Purchases 8,199 Discount received 220 Closing balance (R) 14,321 22,715 22,715

(b)

Bayswater Account Victoria Account £ £ £ £

Bal. c/d 2,660 Bal. b/d 2,174 Bank 2,100 Bal. b/d 1,762 Purchases 486 Disc. rec. 120 Purchases 1,201 2,660 2,660 Bal. c/d 743 2,963 2,963

Westminster Account Embankment Account £ £ £ £

Bank 711 Bal. b/d 2,142 Bank 1,428 Bal. b/d 3,426 Disc. rec. 100 Bal. c/d 1,998 Bal. c/d 1,331 3,426 3,426 2,142 2,142

Temple Account Blackfriars Account £ £ £ £

Purc. ret. 307 Bal. b/d 3,716 Bank 1,296 Bal. b/d 1,296Bank 1,511 Purchases 4,163 1,296 1,296Bal. c/d 6,061 7,879 7,879

Monument Account Aldgate Account

£ £ £ £ Bal. b/d 0 Purc. ret. 621 Bal. b/d 0Bal. c/d 1,437 Purchases 1,437 Bank 200 Purchases 912 1,437 1,437 Bal. c/d 91 912 912

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MODEL ANSWER TO QUESTION 3 CONTINUED (c) Reconciliation £ Purchase Ledger Account balances: Bayswater 2,660 Victoria 743 Westminster 1,331 Embankment 1,998 Temple 6,061 Blackfriars - Monument 1,437 Aldgate 91 Purchase Ledger Control Account balance 14,321 (d) Incorrect additions: list of purchase ledger balances books of prime entry individual accounts

Items omitted: individual accounts control accounts

Incorrect entries: wrong (different) figures Items on wrong side of accounts etc.

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SECTION B CONTINUED QUESTION 4 Southall and Hayes entered into a joint venture on 1 June 2006. The joint venture was to run for three months and the agreement stated that profits would then be divided between Southall and Hayes in the ratio 2 : 1 respectively. At the end of the three month period Southall prepared the following memorandum account:

Southall and Harlington Memorandum Joint Venture Account

for the Year Ended 30 September 2006

£ £

Purchases 6,250 Sales 12,600

Purchases 31,200 Sales 21,200

Purchase returns 400 Sales returns 280

Purchases 14,000 Goods sent from Southall to Hayes 510

Goods sent from Hayes to Southall 850 Storage costs 220

Transport costs 300Allowance to Hayes for use of car on Joint Venture business 600

Transport costs 200 Sales 25,100

Stock taken over by Southall 1,220

Loss: Southall 3,045

Hayes 3,045

60,510 60,510 Hayes is convinced that this memorandum account is incorrect. REQUIRED (a) Redraft the Memorandum Joint Venture Account, in good style, showing the division of the

correct profit/loss between the venturers. You may assume that Southall’s figures (other than the loss) are correct. (b) State whether or not the Memorandum Joint Venture Account is part of the double entry book-keeping system of: (i) Southall (ii) Hayes (c) State why it is necessary for each venturer to keep a separate Joint Venture Account in his/her books and state what it contains.

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MODEL ANSWER TO QUESTION 4 (a)

Southall and Hayes . Memorandum Joint Venture

Three Months Ended 31 August 2006 . £ £ £ Purchases (6,250 + 31,200 + 14,000 Sales (12,600 + - 400) 51,050 21,200 + 25,100 – 280) 58,620Storage costs 220 Stock taken over 1,220Transport costs (300 + 200) 500 Allowance for car use 600 52,370 Profit: Southall (2/3) 4,980 Hayes (1/3) 2,490 _7,470 59,840 59,840

(b) (i) No (ii) No (c) It is necessary for each venturer to maintain an account in which to record the financial

relationship with the other venturer (who will be either a debtor or a creditor). The profit/loss on the venture will also be recorded in this account. The account will be closed by the final cash settlement between the venturers.

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SECTION B CONTINUED QUESTION 5 Barbican plc has an authorised share capital of 6,000,000 £1 ordinary shares. The issued share capital at 31 December 2006 was 2,000,000 £1 ordinary shares, issued at par and fully paid. On 1 January 2007 a further 2,000,000 ordinary shares were offered for sale at £1.20, payable as follows: £ On application (including premium) 0.55 On allotment 0.15 On first and final call on 1 April 2007 0.50 1.20 The following applications were received: Category A - 200 applicants for 10,000 shares each Category B - 100 applicants for 5,000 shares each Category C - 100 applicants for 1,000 shares each. The Directors of Barbican plc decided to allocate the shares as follows: Category A - each applicant to receive 7,500 shares Category B - each applicant to receive 4,000 shares Category C - each applicant to receive 1,000 shares. Any balance of money received on application was to be applied to the amounts due on allotment. All outstanding money was received on both application and allotment and Barbican plc repaid the excess money received. All monies were received in respect of the call, except for one shareholder who failed to pay the call on 1,000 shares allotted to him. These shares were forfeited and reissued at £1.80 per share. REQUIRED (a) Explain the difference between the authorised share capital and the issued share capital of a company. State whether or not it is possible for the issued share capital of a company to be higher than its authorised share capital. (b) (i) Calculate the total amount payable on allotment by two applicants in Category C (ii) Calculate the amount refundable on allotment to three applicants in Category A. (c) Calculate the total amount that will be credited to the Share Premium Account as a result of the forfeiture and reissue of the 1,000 shares. Setting a price for a new issue of existing shares is always difficult. REQUIRED (d) On the evidence provided by the question, suggest whether the issue price should have been higher or lower than £1.20, giving your reasons. The Balance Sheet of Farrington plc at 31 March 2007 included 100,000 redeemable shares of £1 each and retained earnings of £250,000. On that date it was decided to redeem 80,000 redeemable shares at par. REQUIRED (e) Record the above transaction using journal entries. No narratives are required.

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MODEL ANSWER TO QUESTION 5 (a) The authorised share capital is the maximum number of shares a company is permitted to issue. The issued share capital is the number of shares that have been issued. The number issued cannot exceed the number authorised. (b) £ (i) Amount payable on allotment by two Category C Applicants: 2 x 1,000 x .15 = 300 £

(ii) Amount refundable on allotment to three Category A Applicants: Amount paid (3 x 10,000 x .55) = 16,500 Amount due (3 x 10,000 x .75 x (.55 + .15)) = 15,750 750

(c) Amount credited to share premium account: £ Amount received on original issue (1,000 x .7) 700 Amount received on reissue (1,000 x 1.8) 1,800 2,500 Amount due (1,000 x 1.2) 1,200 1,300 (d) The issue price should have been higher because:

(i) it was oversubscribed (ii) the reissued shares received £1.80 each

(e) Share capital Dr 80,000 Share redemption Cr 80,000 Share redemption Dr 80,000 Bank Cr 80,000 Retained earnings Dr 80,000 Capital redemption reserve Cr 80,000

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QUESTION 6 On 1 January 2004 Amersham Ltd paid £320,000 to acquire 70% of the share capital of Chesham Ltd. On that date Chesham Ltd had a credit balance of £30,000 in its Profit and Loss Account. Group policy is to amortise goodwill over a period of 10 years. The summarised Balance Sheets of the two companies at 31 December 2006 were as follows: Amersham Ltd Chesham Ltd £ £ Tangible fixed assets 200,000 160,000 Investment: Shares in Chesham 320,000 - Stock 40,000 50,000 Debtors 33,000 13,000 Bank 4,000 2,000 Creditors (21,000) (9,000 ) 576,000 216,000 £ £ Ordinary Share Capital 400,000 240,000 Profit and Loss 176,000 (24,000 ) 576,000 216,000 At 31 December 2006 Chesham Ltd had in stock goods transferred to it from Amersham Ltd valued at £10,000. These had been charged to Chesham Ltd at 10 times their cost to Amersham Ltd. No dividends have been paid by either company since 2003. REQUIRED (a) Prepare the Consolidated Balance Sheet of the Amersham Group at 31 December 2006. Several shareholders in Amersham Ltd and the minority shareholders of Chesham Ltd are unhappy with the performance of the group. Comments made include the following:

(i) “Chesham Ltd has made losses since acquisition. This indicates bad management.” (ii) “By transferring goods from Amersham Ltd to Chesham Ltd at 10 times their cost, the directors of Amersham Ltd are treating Chesham Ltd unfairly and possibly defrauding the minority shareholders in Chesham Ltd.” (iii) “We have had no dividends for three years. Dividends should be paid immediately.” (iv) “Dividends cannot be paid unless there is cash available, but neither company has much in the bank.”

REQUIRED (b) Critically discuss each of the above comments.

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MODEL ANSWER TO QUESTION 6 (a) Preliminary calculations: £ £ Goodwill Cost of investment 320,000 Less Share of net assets: Share capital 240,000 Profit and loss 30,000 270,000 189,000 131,000 Written off 3 years x 10% 39,300 91,700 Profit and Loss £ £ Amersham Ltd 176,000 Chesham Ltd (.7 (30,000 + 24,000)) (37,800) 138,200 Less Goodwill 39,300 Unrealised profit 9,000 48,300 (9/10 x 10,000) 89,900

Minority Interest

£

£

(216,000 x .3) 64,800

Consolidated Balance Sheet

of the Amersham Group at 31 December 2006

Fixed Assets £ £ Tangible (200,000 + 160,000) 360,000 Intangible - goodwill 91,700 451,700 Current Assets Stock (40,000 + 50,000 – 9,000) 81,000 Debtors (33,000 + 13,000) 46,000 Bank (4,000 + 2,000) 6,000 133,000

Liabilities: Amounts Payable within 1 year: Creditors (21,000 + 9,000) 30,000 103,000

554,700 Capital and Reserves £ Ordinary share capital 400,000 Profit and loss 89,900 489,900 Minority Interest 64,800 554,700

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MODEL ANSWER TO QUESTION 6 CONTINUED (b) (i) Chesham Ltd has indeed made losses since it was acquired (£30,000 + £24,000 = £54,000). However, this is not necessarily due to bad management. If significant, the transfers from Amersham Ltd to Chesham Ltd at ten times cost is likely to have transferred profits from Chesham Ltd to Amersham Ltd.

(ii) The transfer of profits referred to in (i) above will adversely affect the minority shareholders in Chesham Ltd i.e. reduce their prospect of dividends and therefore the value of their shares. It is unlikely however to be fraudulent. (iii) As Chesham Ltd has no distributable profits no dividend can be paid. As far as Amersham Ltd is concerned dividends can be paid. (iv) Dividends can be paid out of distributable reserves, even if it is necessary to borrow in order to make the payment. Borrowing would increase Amersham’s expenses.